$7 Trillion to Fight Climate Change?

Today’s policies to combat climate change cost much more than the benefits they produce. Unfortunately, bad political choices often make these policies even less cost-effective.

Consider the European Union’s 20-20 policy, which targets a 20 percent reduction in CO2 emissions below 1990 levels by 2020. It is important to examine this approach, not only because the EU is pursuing the world’s largest and most ambitious climate policy, but also because other climate policies suffer from similar shortcomings.

The most cost-efficient way to achieve the 20 percent target would be to operate a single, EU-wide carbon-market, which would cost the EU about $96 billion annually by 2020. But the benefits to the entire world would be much lower. Indeed, the onlypeer-reviewed overview of EU climate policy estimates that it can avoid climate-related damage of about $10 billion per year. So, for every dollar spent, the EU stands to avoid about 10 cents of damage.

This does not mean that climate change is not important; it means only that the EU’s climate policy is not smart. Over the course of this century, the ideal EU policy would cost more than $7 trillion, yet it would reduce the temperature rise by just 0.05oCelsius and lower sea levels by a trivial 9 millimeters. After spending all that money, we would not even be able to tell the difference.

Advocates of the EU’s policy often argue that we should pursue such policies nonetheless, because there is a risk that global warming will be much more severe than currently expected. But, though this argument is valid in principle, economic models show that this risk has only a moderate effect on the best policy. Moreover, the absence of any temperature increase over the past 10-17 years has made such worse-than-expected outcomes extremely unlikely.

The real risk concerns the potential for bad political choices to make climate policies worse than necessary. The EU did not just implement a single carbon market in order to meet its target for CO2 emissions. Instead, the EU made a bad deal a lot costlier through a host of partly contradictory policies.

For example, the EU demanded that renewables like wind and solar account for 20 percent of energy supplies by 2020, though this is by no means the cheapest way to cut emissions. In fact, putting up a wind turbine cuts no extra CO2, because total emissions are already capped under the EU-wide carbon-trading scheme. It simply means that when Great Britain installs a wind turbine, it becomes cheaper to burn coal in Portugal or Poland.

Taking into account such poor policies and averaging all macroeconomic models, the EU is more likely to pay around $280 billion per year to avert $10 billion in damage. In other words, the poor design of EU climate policies triples the cost and prevents only three cents of climate damage per dollar spent.

But it gets worse, because these models still assume that the EU picks the cheapest renewables to fulfill its requirements. Instead, most EU countries give higher subsidies to the most costly renewables.

For example, cutting a ton of CO2 with on-shore wind turbines in Germany probably costs about $35, avoiding about 14 cents of climate damage per dollar. But offshore wind turbines cost about $150 per ton of CO2, avoiding just three cents of climate damage per dollar.

Biofuels are even less efficient, costing more than $300 per ton of CO2 avoided, while doing just over one cent of good per dollar. And solar takes the absolute prize, costing more than $800 per ton of CO2 to do less than a cent of good per dollar spent.

These prices are not unique to Europe. China pays $38 per ton of CO2 avoided with wind power, for example, while the US pays around $600 for cutting a ton of CO2with biofuels.

Moreover, when the EU decides to cut its domestic emissions, part of the reduction simply migrates elsewhere. If making a product in the EU costs more because of higher energy costs, the product will likely be made somewhere else, where energy is cheaper, and then imported into the EU.

In fact, new studies show that 38 percent of the EU carbon cuts leak elsewhere, meaning that European climate policy avoids not three cents of climate damage per dollar spent, but less than two. From 1990 to 2008, the EU cut its emissions by about 270 million metric tons of CO2. But it turns out that the increase in imports from China alone implied an almost equal volume of extra emissions outside the EU. Essentially, the EU had simply shipped part of its emissions offshore.

We need a smarter approach to tackling climate change. Rather than relying on cutting a few tons of incredibly overpriced CO2 now, we need to invest in research and development aimed at innovating down the cost of green energy in the long run, so that everyone will switch.

For now, our current climate policies are poor—and our politicians consistently find ways to make them even poorer. They may please farmers and other interest groups, but overall they simply drive up costs and reduce already-minimal benefits.

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